China considers pipeline reform to boost gas supply

* PetroChina-dominated grid limits small gas producers

* Small producers forced to sell at discount

* Mandating access could encourage shale, coal bed gas
output

By Chen Aizhu and David Stanway

BEIJING, Nov 22 (Reuters) - As China struggles to rid cities
of choking smog, one of the early priorities for Beijing's
economic reforms will likely be to force state-run PetroChina
to allow private producers fair access to natural gas
pipelines.

Without fair access to the distribution network, independent
producers have no incentive to develop the country's vast gas
reserves to their full potential. Already the world's
fourth-largest gas user, China's leaders want to boost domestic
output to accelerate the substitution of cleaner-burning gas for
coal to fuel power and heating.

They included gas price reform and some curbs on the role of
state monopolies in their boldest reforms in decades unveiled
last week. Industry experts say both are needed to maximise gas
output and ease annual winter supply crunches that have slowed
the switch from coal in power plants and forced authorities to
ration industrial gas use.

China's largest oil-and-gas producer, PetroChina, built and
runs nearly three quarters of the 54,000-km natural gas pipeline
system across China. It controls most of the large,
long-distance trunk lines that pipe gas from far-flung fields to
fast-growing cities. Other state energy firms - Sinopec
and CNOOC - run the remaining trunk pipelines but are
much smaller operators compared to PetroChina.

Some independent gas producers say PetroChina has imposed
unfair conditions on them for access to the grid, erasing the
profit-incentive for boosting output, and others are asking the
state giant for better access.

"To have more access to the pipelines and more access to
broader markets would bring more incentive to producers," said a
senior executive with Asian American Gas, which pumps gas from
China's coal seams in Shanxi province.

"We have a plan to access the trunk lines and serve the
coastal markets along with our production growth in the near
future. The recently proposed new policies are actually in line
with the party's new policy of letting the market decide the
allocation of resources."

Open access to pipelines was one of the key factors that
enabled the U.S. shale gas industry to revolutionise the energy
sector of the world's largest economy. China's shale reserves
are potentially bigger than those in the United States, but the
Chinese sector is undeveloped.

PetroChina demands independent producers sell the gas they
want to move through the pipelines at a discount to the oil
giant rather than charging a transit fee, said executives with
independent producers. They declined to be named as both were
unauthorised to speak to openly the press.

PetroChina declined to comment on the terms of deals it has
made for third party access to its pipelines. Only a few
independent producers needed access and they were able to
negotiate terms, said company spokesman Mao Zefeng.

"It is unfair that any third party has unconditional rights
to use our pipelines," the spokesman said. "As an integrated
upstream and downstream oil company, gas pipelines are one of
the components connecting upstream production with downstream
operations. Our own oil-and-gas need pipeline capacity
allocation."

PetroChina pays independent producers 70-80 percent of the
retail value of the gas, the executives with independent
producers said. It then sells the gas to consumers at the retail
price, pocketing the difference and preventing independents from
competing for customers.

To avoid selling at a discount, independent producers stick
to pumping from gas fields to nearby retail markets they can
reach without using PetroChina's pipelines.

That means small producers have no motive to boost output
above a level that meets local consumption and counters
Beijing's aim of boosting natural gas output nationally through
encouraging private enterprise to develop unconventional energy
sectors such as shale gas and coal-bed methane.

While conventional oil-and-gas fields are reserved for
China's state-owned energy giants, Beijing has allowed private
firms a role in the unconventional sector.

Production of gas from China's coal seams has been more
successful than shale, but output would increase more quickly
with better pipeline access, industry sources said.

"One of the boxes (investors in gas exploration) want to
tick is access to market managed in a regulated and transparent
way because there is access to a pipeline," said Beijing-based
Gavin Thompson of energy consultancy Wood Mackenzie.

Beijing has introduced subsidies for shale gas and hiked gas
prices this year as it looks to boost investment in the sector.
Prices need to rise again to lure investors, industry experts
say, with hikes of at least 15 percent a year for the next two
to three years needed to make shale profitable.

As the role of gas in the economy grows, hiking prices so
much may be difficult without fuelling inflation.

China's natural gas consumption is expected to grow to 250
billion cubic metres per year by 2015, up 70 percent from 2012.
Imports will need to double to 80 bcm as domestic supply fails
to keep pace, industry experts have forecast.

DRAFT REFORM

The country's top economic planner, the National Development
and Reform Commission (NDRC), started work on a new policy for
gas pipelines long before the government announced its reforms.

A policy draft seen by Reuters that the NDRC circulated in
August for feedback from industry participants, calls for
pipeline operators to provide non-discriminatory transmission
services to third-parties.

Forcing state giants to allow access on an equal footing to
independents would stimulate investment, while leaving the
state-owned firm in control of the assets it has built. That may
fit into Beijing's plans for slow monopoly reform.

A deeper, longer-term reform would be to establish a
separate operator to run the pipelines. That reform is not in
the draft, but industry experts say it would accelerate the
expansion the grid needs.

Until then, China is relying on state energy giants to build
the pipes. They are in the midst of a plan to nearly double the
grid's size by laying 44,000-km from 2011-2015. Top gas consumer
the United States, which burns five times as much as China, runs
pipeline grids nearly 10 times those in China.

The government needs to ensure improved access to the
pipelines does not jeopardise expansion of this hugely capital
intensive sector.

"The balance the government is trying to seek is to
incentivise third-party investment but at the same time to make
sure the pace of the pipeline development is maintained," said
Wood Mackenzie's Thompson.

The NDRC reform draft also seeks to introduce more
transparent accounting of transport costs in a sector that has
bundled transmission and gas sales together.

China has three tiers of pipelines: trunk lines built by the
big state energy firms, intercity lines built by state firms
together with local government-backed distributors, and city
grids. The grids are run by distributors such as ENN Energy
Holdings Ltd and China Gas Holdings Ltd.
(Addtional reporting by Judy Hua and Beijing newsroom; Editing
by Simon Webb)